Demand
2.1 Demand
Demand refers to the
quantities of a commodity that the consumers are able to and willing to buy at
each possible price, during the given period of time, other things remaining
same.
Elements of demand for a commodity
-
want for a commodity,
-
possession of money to satisfy the want
-
willingness of consumer to spend money on that commodity.
So,
demand can be defined as the desire
to purchase a commodity, backed by sufficient buying power and intention to
spend.
2.2 Determinants of demand
There are many economic,
social and political factors which influence the demand for a commodity, like:
a. Price of the commodity: Price of commodities significantly influences the
demand. As the price of a commodity changes, it causes an opposite change in
the demand for the commodity. So, rise in price of a goods causes a decrease in
its demand and vice versa.
b. Tastes and preference: Tastes and preference, like fashion, habits,
advertisement, culture, etc. influence the demand for special product, quality
etc..
c.
Price of Related Goods: Demand for the commodity is also influenced by
change in the price of related (complementary & substitute) goods.
(i) Complementary goods: Some goods, are consumed
together (e.g. car and petrol etc.), hence jointly demanded. Now if the price
of the car rises, demand for car and petrol will simultaneously decline and
vice versa. So, Price and demand of complementary goods are inversely related.
(ii) Substitute goods: These are those goods
which can replace each other (like petrol and diesel). If the price of petrol increases,
its demand will decline resulting to a rise in demand for diesel (also known as
‘cross demand’). Thus, there is a direct relationship of price and substitute
goods.
d. Government policy: Government policy, (e.g. tax, import or export policy) influences the
demand of a commodity. When government imposes tax on any commodity, its price
rises resulting to decline in its demand.
e. Size and density of population: Demand for commodity in densely
populated area will be more compared to less populated areas. So, density of
population has a direct relationship in influencing demand.
f. Distribution of income and wealth: Demand for all the commodities is likely to
be high in regions having equality of income and wealth than the regions where
there is great inequality between economic conditions of people.
g. Economic change: If a country is passing through a period of boom, there will be an
increase in market demand. During the period of recession, the market demand
will be on the lower side.
2.3 Law of demand
According to Marshall, The law of demand states that other
things being equal, the demand increases with a fall in price and diminishes
when price increases.
The
term ‘other things being equal’ implies
the prices of related goods, income of the consumers, their tastes and
preferences etc. remain constant.
2.3.1
Exceptions to the law of Demand
The Law of Demand does not apply in following
cases:
i)
Conspicuous consumption: There are some goods like women’s hats) which are bought, not for
their intrinsic worth, but for their “snob-appeal”. This are called
“conspicuous consumption” or articles of ostentation. If prices of such goods
rise, their use becomes more attractive and they are bought in larger
quantities. If fish becomes more expensive, some people will buy more of it
just to show their high status. On the other hand, when such goods become
cheaper, they are bought less. For example, higher the price of diamonds,
higher is the prestige value attached to them and hence higher is the demand
for them.
ii)
Speculative markets: In the speculative markets, a rise of prices is frequently followed by
larger purchases and a fall of prices by less purchases. When the price of a
share rises, people hope further rise and rush to purchase. When price declines,
they wait for further declines and stop purchasing. The same thing may happen for
other commodities where purchases are made on speculative basis. But it is a
short period event.
iii)
Giffen Goods: Giffen found that
poor spent the major part of their income on potatoes (which were cheap) and a
small part on meat (which were costlier). When the price of potatoes rose, they
had to economise on meat. To fill up their daily requirement of food, more potatoes
had to be bought. Thus increase in the price of potatoes led to increased sales
of potatoes. This is known as the Giffen Effect. Normally found in the case of
cheap necessary foodstuffs.
iv)
The income effect: The demand curve may be affected by the income effect. If the
income effect is positive (i.e. income elasticity of demand exceeds zero) we
can expect a downward sloping demand curve. But, if the income effect is
negative, particularly in case of inferior good, the result may not be a
downward sloping curve. If the total expenditure of the commodity is small,
the income effect will have less implication on the demand curve and there will
be an inverse relation between price and demand.
v)
Ignorance effect: Generally, it is assumed that a household has perfect knowledge about
price and quality of goods. However, in practice, a household may demand larger
quantity of a commodity even at a higher price because it may be ignorant of
the lowest ruling price of the commodity.
vi)
Impulsive purchases: Impulsive purchases means ‘purchases by impression’. At times consumers
tend to make impulsive, without any cool calculation about price and usefulness
of the product e.g. chocolate, candy etc.
vii) Insignificant portion of income to be spent on commodity: If a commodity occupies an
insignificant portion in the total budget of the consumer, variations of its
price may not cause change in demand for the commodity. In this case, real
income is not changed significantly with change in price (E.g., salt, match
boxes), so the curve is parallel to the price axis.
2.4 Demand Schedule
A Demand schedule may be
defined as a list of the different quantities of a commodity which consumers
purchase at different period of time, depicting the relation ship between
quantities of the commodity demanded at different prices.
Types of Demand schedule
(i)
Individual Demand Schedule
(ii)
Market Demand schedule
a.Individual Demand schedule
It refers to the different quantities of a
given commodity which a consumer will buy at various prices
Example Data of Individual Demand Schedule
|
Price (Rs.)
|
Quantity Demanded
|
|
1
|
10
|
|
14
|
8
|
|
15
|
6
|
|
16
|
4
|
b.Market Demand schedule
Market demand schedule refers
to the quantities of a given commodity which all consumer will buy at different
price at a given moment of time
Example Data of Market Demand Schedule
|
Price (Rs.)
|
X’s Demand (1)
|
Y’s Demand (2)
|
Market Demand schedule (1 + 2)
|
|
1
|
4
|
15
|
4
+ 15 = 19
|
|
2
|
3
|
14
|
3
+ 14 =17
|
|
3
|
2
|
13
|
2
+ 13 = 15
|
|
4
|
1
|
10
|
1
+ 10 = 11
|
Market Demand
Schedule exibits the total demand of all consumers in the market at different
prices of the commodity.
2.5
Demand Curve
Demand
Curve is
simply a graphic representation of demand schedule. It shows the relationship
between different quantities demanded at different possible prices of the given
commodity.
The
Demand Curve shows the maximum quantities per unit of time that the consumers
will take at various prices.
Types of Demand Curve
(i)
Individual
Demand Curve: It is the graphic presentation of individual Demand schedule.
So, it shows different quantities of a commodity
demanded by a consumer at different prices.
(ii)
Market
Demand Curve: It is the graphic presentation of market demand schedule.
So market demand curve shows total
quantities of a commodity demanded by all the consumers in the market at
different prices.
Demand
Curve Slopes
Inverse
relationship between demand and price makes the demand curve negatively sloped.
According to traditional theory of
demand, the following factors are responsible for the negative slope
of the demand curve:
(i)
Law
of Diminishing Marginal Utility: The law of demand is based on the law of
diminishing marginal utility which states that as the consumers buy more and
more quantity of a commodity, the satisfaction obtained from each successive
unit goes on diminishing. Consumer always attempts to maximize his satisfaction by equalizing the marginal utility of a commodity with its
price.
So, the consumer will buy additional units only when the price
declines. Therefore the demand curve slopes downward as the marginal utility
curve also slopes downwards.
(ii)
New
Consumers: After decline in commodity price, many consumers, unable to purchase
earlier shall now start to buy the commodity, causing increase in demand of the
commodity. So, there is an inverse relationship between demand and price, which
causes the demand curve to slope downwards.
(iii) Multiple
use of commodity: Some commodities are put to several use (e.g. coal,
electricity, etc.). When the prices of such commodities go up, they will be
used only for essential purposes and their demand will be limited. Similarly,
when their price decline, they are used for varied purposes for satisfying
different demands. So, there is a inverse relation between demand and price
which makes the demand curve slope downwards.
2.6
Change in Demand
The change in demand may be caused due to:
-
Expansion &
contraction in demand
-
Increases & decreases
in demand
2.6.1 Expansion
& Contraction in Demand
When the demand
rises due to the decline in its price, it is called Expansion in demand, but
when the demand decreases due to the increase in its prices, it is called contraction in demand.
(i)
So, expansion or contraction refers to change in
demand only due to the change in price, but not due to the change in other
factors of demand, (other factors of demand should remain constant).
(ii)
The expansion or contraction in demand is also
known as movement along the demand
curve/change in the quantity demanded.
Shifting of
demand: When
due to change in factors other than price of the same commodity (like change in
taste, Income etc.), the demand changes, the entire demand curve shifts either
upwards or downwards. This is called a shifting of demands curve.
2.6.2 Increase &
Decrease in Demand
Increase or decrease in demand due to change in any
other factor, other than price, is called respectively ‘Increase in Demand ‘and’ Decrease in Demand.
Important causes for
increase in demand
(i) Increases in income of the
consumer.
(ii) Increases in price of
substitute goods.
(iii) Fall in price of
complementary goods.
(iv) Consumer preference shifts.
(v) Price of the commodity is
expected to increase in near future.
(vi) Increase in number of
consumers.
Important causes for
decrease in demand
(i) Fall in income
(ii) Fall in price of substitute
goods
(iii) Rise in price of
complementary goods.
(iv) Shift in taste &
preference.
(v) Price of the commodity is
expected to decrease in near future.
(vi) Decrease in the number of
consumers.
2.6.3 Goods
and its relationship with changes in demand
i)
Superior Goods: When the income of consumer increases, the
demand for the superior goods also increases. Thus whole of the demand curve
shifts right ward. In the opposite case, the demand of superior goods declines
and the demand curve shifts leftward.
ii)
Inferior Goods: Demand for inferior goods rises
with a decline in income. The whole of demand curve shifts right ward. The
demand for inferior goods reduces with rise in income, causing the demand curve
shift leftward.
iii)
Substitutes: In the case of substitutes (e.g. petrol
& diesel), when the price of substitute declines, the demand of commodity
also reduces and therefore the demand curve shifts leftward. In the opposite
case, the demand of commodity rises and the demand curve shifts rightward.
iv)
Complementary Goods: When the price of complementary goods (e.g. car &
petrol) increases, the demand for the commodity declines and the demand curve
shifts leftward. In the opposite case, i.e. when the price of complementary
goods declines, the demand for commodity increases and therefore the demand
curve shifts rightward. In case
of rise in the price of complementary goods, demand curve shifts to left.
v. Substitution
effect: Substitution
effect means the change in the consumption or demand of two commodities as a
result of their relative change in prices, the total utility remaining the
same.
vi. Income effect:
When price
of a commodity changes, the real income of a consumer also undergo a change.
Real income denotes consumer’s purchasing power. If price of a product
decreases, the real income of a consumer rises and he purchase more units of
the product. The demand curve slopes downward due to this income effect. This
is called income effect for change in demand.
2.7
Elasticity of Demand
Elasticity of
demand refers to the effect of quantity demanded of a commodity due to change
in one of the variables on which demand depends (e.g. price of commodity, price
of related goods, income level etc.).
Formula
Elasticity e = (%
change in the quantity demanded) / (% Change in any one of the variables of
Demand)
Types of
Elasticity of Demand:
a.
Price elasticity
b.
Income elasticity
c.
Cross elasticity
2.8 Price Elasticity of
Demand
Price elasticity
of demand refers to the effect of quantity demanded of a commodity due to change
in price of that commodity. It is expressed as percentage change in quantity
demanded of a commodity, divided by percentage change in its price.
Formula:
Price Elasticity Ep = (% change in the quantity demanded) / (% Change in price)
Symbolically, Ep = (∆q / ∆p) x (p/q),
where Ep= Price Elasticity, P = Price, ∆q = Change in quantity, ∆p=
Change in price.
Value
Price elasticity will be negative in case of normal goods, as there is
negative relationship between demand of normal goods and its price. However,
price elasticity will be positive in case of giffen goods, due to the positive
relationship between demand of giffen goods and its price.
2.8.1 Measurement of Price
Elasticity
Methods to measure the elasticity of demand:
a.
Total Outlay method,
b.
Point elasticity method,
c.
Arc elasticity method.
2.8.1.1 Total
Outlay Method
(i)
Elasticity of Demand can
also be defined in terms of the total outlay on the commodity.
(ii)
Let us assume a commodity
demand changes exactly in proportion to the changes in price, as follows:
|
Price
|
Amount Purchased
|
Total Outlay
|
|
Re.2
|
2,400
|
Rs.4,800
|
|
Re.4
|
1,200
|
Rs.4,800
|
|
Re.6
|
800
|
Rs.4,800
|
|
Re.8
|
600
|
Rs.4,800
|
|
Re.12
|
400
|
Rs.4,800
|
(iii) In this case we find that the total outlay of the consumers on the
commodity remains the same, whatever the price may be.
-
The elasticity of demand
is said to be unity.
-
If, when price falls, the
total outlay on a commodity increases, the demand for it is called Elastic.
-
If, when price falls, the
total outlay is reduced, the demand for it is called Inelastic.
2.8.1.2 Point
Elasticity Method
|
(i)
In this method,
elasticity at a given point on the demand curve is measured. Here we make use
of derivatives, rather than finite changes in price and quantity.
(ii)
Thus it is defined as:
EP = (-dq/dp) x (p/q)
Where, (-dq/dp) = derivative of quantity
with respect to price at a point on the demand curve,
P= Price, Q = Quantity.
(iii)
Elasticity of demand is
different on different points on the demand curve.
(iv)
Point elasticity can
also be calculated as:
(Lower Segment on the
demand curve)/(Upper Segment on the demand curve)
(v)
From the above given
formula, the elasticity of demand at point P on the demand curve DD1
is PD1/PD.
|
 |
2.8.1.3 Arc Elasticity
(i)
It is an estimation of
the average responsiveness to price change shown by a demand curve, over some
finite stretch of the curve.
(ii)
Since averages are taken,
we use {(p1+p2)}/2 rather than P, and {(q1+q2)}/2
rather than q.
(iii) The formula for are elasticity is:
Ed = {(Change in quantity demand)/(Original
quantity plus quantity after change)} / {(Change in price)/(Original price plus
new price after change)}
(iv) Symbolically, it can be expressed as ∆q / (q1+q2)
EP = ∆p / (p1+p2)
= (∆q / ∆p) x {(p1 + p2) / (q1+q2)}
|
Where,
|
∆q
|
= Change in quantity
|
 |
|
|
∆p
|
= Change in price
|
|
|
|
q1
|
= Marginal quantity
|
|
|
|
q2
|
= New quantity
|
|
|
|
p1
|
= Marginal price
|
|
|
|
p2
|
= new price
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2.8.2
Determinants of Price Elasticity of Demand
There are many factors which affects the elasticity
of demand for a commodity, like:
i)
Nature of commodity: The demand for a commodity depends entirely on its nature. In case of
necessities, the demand is inelastic, as they are to be purchased even though
their prices rise (e.g. food) on the other hand, the demand for luxuries is
elastic (e.g. car). In case of luxury goods, if price increases, demand also
decreases.
ii)
Number of uses: A commodity which
serves a number of purposes will have an elastic demand (e.g. Milk,
electricity, etc.), whereas a commodity whose use is restricted, the demand
shall be inelastic (e.g. Bicycle). Decrease in price of goods having multiple use
also brings significant increase in demand of that goods.
iii)
Substitute goods: Availability of substitute have significant impact on the degree of
elasticity. The demand for a commodity having close substitute is elastic (e.g.
coffee, cold drink etc.) whereas a commodity whose close substitutes are not
available (like salt), the demand will be inelastic.
iv)
Future expectation about prices: If there is a prediction that price of a commodity is likely to rise in
the near future, its demand shall become elastic in the present.
v)
Consumer habit: If the consumer is
habitual of a certain commodity, he will definitely purchase it irrespective of
its price, and the demand for such goods shall be in elastic (e.g. liquor
etc.). In case of addictive goods, (e.g. cigarette), price increase cannot
bring significant decrease in demand.
vi) Possibility of postponement: If the demand for a particular commodity can be
postponed for sometime, its demand will be elastic (e.g. VCR, Washing machine
etc.). If price goes up, people try to postpone its purchase & its demand
fall significantly. On the other hand, demand for foodgrains, medicines, etc,
is inelastic as their consumption cannot be postponed.
vii) Durability: In case of durable goods (e.g., a furniture), a change in price would
not affect demand very much, because most of the consumers will not busy new
piece of furniture until the old one is totally worn out. Therefore, durable
goods usually have low elasticities of demand.
viii) Income level: People who have more purchasing power may not change quantity demanded
even if price changes. On the other hand for poor people, demand is more sensitive
to change in price.
ix) Proportion of income to be spent on commodity: Commodities for which
consumers spend a very less portion of income (like match boxes, salt) have
very inelastic demand, as even substantial change in their price will not cause
enough impact to his demand.
2.8.3
Degree of Price Elasticity of Demand
Types of Price Elasticity
|
i)
Perfectly Elastic: When a small fall in price
leads to infinitely large purchases, demand is said to be Infinitely Elastic
or Perfectly Elastic (E = µ ).
ii)
Elastic: When a small
fall in price leads to a large but a finite increase of purchases, demand is
called Elastic (E< µ and >1).
iii)
Unitary Elastic: When a change of price causes an exactly proportional change of demand,
demand is called Unitary Elastic (E = 1).
iv)
Inelastic: When a fall of price reduces total outlay
but not to zero, demand is Inelastic (E<1 and > 0).
v)
Perfectly Inelastic: When a change of price causes no change in the amount purchased,
demand is said to be Infinitely Inelastic or Perfectly Inelastic (E = 0)
|
 |
2.9
Income Elasticity of Demand
Income Elasticity of Demand (EI) measures the responsiveness
of quantity demanded of a commodity, to a change in Consumers’ Income, when all
other factors (Price of the Commodity, Substitutes, and Prices of Related
Commodities) are constant.
Formula
(i)
EI = (% Change
in Quantity Demanded / % Change in Consumers’ Income) = {(Change in Quantity) /
(Original Quantity)} x 100 / {(Change in Income) / (Original Income)} x 100
= {(Change in Quantity) / (Original Quantity)}
x {(Original Income) / (Change in Income)} = {(∆q/q) x (i/∆i)} = Symbolically,
EI = (∆q/∆i) x (i/q)
Here, q = quantity, i = Income, ∆q = change in
Quantity, ∆I = change in Income.
Value
Generally, Income Effect is positive, so Income Elasticity of Demand is
also positive. However, there may be negative Income Elasticity in case of
Inferior Goods.
Income Elasticity
of Demand
|
Perfectly
Inelastic
|
ei = 0
|
There
is no impact of change in income on the demand of a commodity
|
|
Inelastic
|
0< ei<1
|
%
Change in quantity demanded <% change in income
|
|
Unitary Elastic
|
ei = 1
|
%
Change in quantity demanded = % Change in income.
|
|
Elastic
|
> ei>1
|
% Change in quantity demanded > % change
in income
|
|
Perfectly
Elastic
|
ei = µ
|
Due
to very small change in income, which tends to zero, the quantity demanded
change substantially.
|
Value of Income Elasticity of Demand (ei)
for different quality of goods
-
Inferior Goods : ei < 0
-
Necessary Goods : 0<
ei<1
-
Luxury (superior) goods : ei <
1
Normal Goods
Increase in income and
demand of normal goods have a positive relationship. So, increase in income
will result in rise in demand of normal goods.
Fall in price of normal
goods means increase in purchasing power of consumer. So, due to income effect,
more normal goods are purchased. It has also substitution effect because in
place of relative inferior goods, consumer starts to buy more normal goods.
2.10
Cross Elasticity of Demand
Cross elasticity
refers to the effect on demand of a commodity due to change in the price of
other goods (substitute or complementary).
Formula
Cross Elasticity EC= (% Change in the quantity demanded) /
(% change in the Price of other commodity), or
EC =
(∆qx / ∆py) x
(py/qx)
Where,
qx = Quantity
demanded of commodity X, ∆qx = Change
in the quantity demanded of commodity X
py = Price
of commodity Y, ∆py = Change in the price of commodity Y
Values
Positive
cross elasticity of demand implies substitute goods : Tea & Coffee, Red
Pencil & Blue Pencil, Coke & Pepsi etc.
Negative cross elasticity
of demand exhibits complementary goods : Car & petrol, Tea & sugar, Pen
& Ink etc.
‘Zero’ cross elasticity
implies that goods are not related to each other.
Examples
(i)
If the quantity demand A increases by 10% when the
price of B increases by 20%, the cross price elasticity of demand between X and
Y will be:
EC of AB commodity = A = 10% / 20% = + 0.50. EC (+0.50)
indicates that A and B are substitute goods.
(ii)
If the quantity demand of A increases by 10%, when
the price of B decreases by 20%, the cross price elasticity of demand between A
and B will be:
EC of AB commodity = %∆QA / %∆PB = 10% / 20% = -0.50 EC
(-0.50) indicates that A and B are Complementary goods.
2.11 Importance
of Elasticity of Demand
The knowledge of elasticity of demand is significant in practical life:
i)
Utility in foreign
trade: Government imposes a higher tax rates in case of goods having inelastic
demand, and a lower tax rate for goods having elastic demand.
ii)
Utility in
forecasting demand: It is possible to forecast the demand for a
particular commodity by analyzing its elasticity.
iii)
Utility in price
fixation: The concept of elasticity assists a monopolist in determining prices
for his product. He will settle up a higher price in those markets where demand
for his product is inelastic. Conversely, he will fix a lower price for the
same product in some other market, where demand is elastic.
